ii List of Figures Figure 1.1 Labor Force Participation Rates in Germany and Switzerland by Age Group and Gender Over Time .................................................................. 13 Figure 2.1 Relative Frequency of Transitions to Disability Retirement Over Time ... 42 Figure 3.1 Relative Frequency of Transitions to Retirement by Age and Gender Over Time .......................................................................................................... 75 Figure 3.2 Predicted Retirement Probability Before and After Reform by Level of Education and Gender ............................................................................... 76 Figure 4.1 Age of Entitlement for Retirement Benefits by Month of Birth .............. 128 Figure 4.2 Relative Frequency of Age of Benefit Claiming by Birth Cohort and Gender ..................................................................................................... 129 Figure 4.3 Employment Status at Given Ages by Birth Cohort 130 Figure 4.4 Net Present Value of Social Security Income by Age of Benefit Claiming for Different Ages of Employment Exit (Hypothetical Employment Biography) .............................................................................................. 131 Figure 4.5 INCB: Accrual in Social Security Wealth for One Year of Delay of Retirement Entry by Gender, Year of Birth, and Age ............................ 132 Figure 4.6 Expected Survival Until Employment Exit and Until Benefit Claiming Population at Risk by Spell Length and Gender ..................................... 133 Figure 4.7 Excess of the Number of Individuals out of Employment over the Number of Individuals Receiving Benefits by Age and Gender ........................... 134

1 Introduction The political debate in the western world about sustainable financing of old-age income lasts already several decades. Both, pre-funded private pensions and public pensions, which are usually financed in the framework of pay-as-you-go (PAYG) systems, each imply specific problems and risks. Fund-based pensions 1depend on the overall development of asset values, whereas PAYG-pensions depend on demographic developments and labor market trends. Public pension schemes have 2to cope with increasing longevity and decreasing fertility, which in turn lead to an increase of expenditures and a decline of revenues. Moreover, individual labor market behavior affects the financial situation of PAYG-financed pension schemes: if individuals extended their working life according to their increasing life expectancy, the financial problems caused by demographic trends could be alleviated. Yet, the reverse is observed in reality: labor force participation among the elderly has been decreasing in most industrialized countries since the 1960s, thereby further aggravating the effects of the demographic trend. Public pension schemes set incentives either to stay in or to withdraw from the labor force. By setting incentives to retire early, pension systems may exacerbate the financial problems they face. This work examines the effect of financial incentives that are caused by public pension schemes on the timing of retirement. It provides evidence from Germany and Switzerland. In both countries, pension systems have

1 For example, private pension funds lost 23% of their investment’s value on average in the OECD in 2008, due to the financial crisis (OECD, 2009a). 2 Longevity among older individuals increased strongly in the OECD since the 1960s. The remaining life expectancy of individuals aged 65 rose by one fourth in the OECD. It was 20.1 years for females and 17.6 years for males by 2006. At the same time, fertility rates averaged to 1.65 across OECD countries in 2006, which is far below the level that ensures population replacement (OECD, 2009b). 1 recently undergone reforms. The resulting changes of financial incentives to retire are used to evaluate the effects of social security systems on labor market behavior. 1.1 Basic Principles of the Retirement Insurance Systems in Germany and Switzerland In most OECD countries, there is a mix of different schemes that provide income for the elderly. Usually, there is a first pillar of the public pension system that provides a basic income for the elderly. A second, earnings-related pillar shall provide an adequate income relative to previous earnings. Moreover, some countries provide subsidies for voluntary private savings as a third pillar. Yet, public pension systems vary widely across countries in terms of their generosity. Compared to other OECD countries, Germany and Switzerland provide moderate old-age benefits on average. For example, in the UK the maximum public pensions from the first and the second pillar sum up to only 50% of the average income. (Bäcker et al., 2008). The 3net replacement rate amounted to 40.1% for an average earner in 2006. Hence, additional private savings are essential to prevent poverty during old-age. In comparison to that, the public pension system e.g. in the Netherlands is generous. In 2006, the net replacement rate was 103.5% for an average earner. The public pension systems of Germany and Switzerland range in the middle of these two extremes, with 4net replacement rates of 61.3% (Germany) and 64.5% (Switzerland) (OECD,

3 Here, the net replacement rate is defined as the amount of net benefits relative to the most recent net earnings. 4 The pension system in Switzerland is based on two pillars, and it is ambiguous whether the second pillar can be interpreted as part of the public system or as a private scheme, since it has characteristics of both (see below). For an average earner, 38.9% of the pension income is drawn from the second pillar on average, and 61.1% from the purely public first pillar. I follow the description in OCED (2009a) where both pillars are considered a part of the public pension system. 2